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CIRCOR International, Inc. (NYSE:CIR)

Q1 2008 Earnings Call Transcript

May 1, 2008 1:00 pm ET

Executives

Curhan McCann – IR

Bill Higgins – President and CEO

Fred Burditt – VP, CFO and Treasurer

Analysts

Charlie Brady – BMO Capital Markets

Kevin Maczka – BB&T Capital Markets

Mike Schneider - Robert W. Baird

Ned Armstrong – FBR

Ron Fischer – U.S. Steel

James Wong [ph] – Gabelli

Richard Glass – Morgan Stanley

Operator

Good day, ladies and gentlemen, and welcome to the CIRCOR International first quarter 2008 earnings conference call. Today's call will be recorded. At this time, all participants have been placed in a listen-only mode. The floor will be open to questions following the presentation. I will now turn the call over to your host, Curhan McCann, from the company's Investor Relations firm. Please go ahead, sir.

Curhan McCann

Thank you very much and good afternoon everyone and welcome to CIRCOR International 's first quarter 2008 earnings call. Our objectives today are to review the company's recent performance and provide an updated outlook on 2008 with Bill Higgins, the company's President and CEO, and Fred Burditt, CIRCOR's CFO. After their comments, we will then go to Q&A.

But before we start, two administrative items. First, the slides we will be referring to today are available on CIRCOR's Web site at www.circor.com under the link Quarterly Earnings from the Investors page. Second, today's discussion contains forward-looking statements that identify future expectations. These expectations are subject to known and unknown risks, uncertainties and other factors. For a full discussion of these risk factors, we advise you to read about them in the company's Form 10-K, which also can be viewed on the company's Web site. CIRCOR's actual results could differ materially from those anticipated or implied from today's remarks.

Let me now turn the call over to CIRCOR's CEO, Bill Higgins.

Bill Higgins

Good afternoon, everyone. As you saw in our earnings press release last evening and our updated guidance on April 18, we had a great first quarter with fully diluted earnings per share of $0.76, which included $0.01 for special charges. Orders, backlog, revenues and margins were up compared to the first quarter of 2007, as well as sequentially compared to the fourth quarter of 2007. We will discuss segments later, I would like to note that this performance is broad based across CIRCOR.

The company received orders totaling $237 million during the first quarter of 2008, which is up 27% over the first quarter of 2007 and 39% above the fourth quarter of '07. Our backlog ended the first quarter at a record $452 million, 45% over the first quarter of 2007 and 15% above the fourth quarter '07. Many of the global markets we serve including energy, aerospace remain solid. We also had new order activity in maritime. Revenues for the first quarter were $177 million compared to $161 million in the first quarter of last year, an increase of 10% and I will note, with a strong tailwind from foreign exchange.

So the top line performed well and we have backlog to continue good performance going forward. But really the best story in the quarter was our margin expansion. Operating income was $19.5 million in the first quarter compared to $12 million a year ago, which was an increase of 62%. Operating margins were 11% in the first quarter compared to 7.4% in the first quarter of last year, an increase of 360 basis points. And similar to our order in revenue story, operating margin expansion was broad based across CIRCOR, with improved performance in both the energy and the Instrumentation & Thermal Fluids segments.

Let me now turn the presentation over to Fred.

Fred Burditt

Thanks, Bill. I will be referring to our presentation slides starting with slide three, which shows consolidated results for CIRCOR. As Bill has outlined, we had a very good quarter, with a solid level of orders, record quarterly revenue, near-record earnings and we finished the quarter with a new record backlog.

For the quarter, the consolidated revenue increase of 10% includes 6% due to currency, primarily the euro appreciation versus the U.S. dollar. The currency benefit impacted the energy segment by approximately 9% and the Instrumentation & Thermal Fluid segment by approximately 4%. Regarding consolidated operating income, we grew 62% over same period last year, about 15% of which was due to currency. The first quarter operating margins at 11% were the best performance since CIRCOR was formed in 1999. We will elaborate later when Bill discusses the segments.

Regarding diluted earnings per share, the $0.76 for the quarter included special charges of $0.01 due to the impact of the retirement agreement with the prior CFO. The $0.45 in the first quarter of 2007 included special charges of $0.03, largely related to our Instrumentation & Thermal Fluid product segment closing a U.S. facility. Free cash flow is even with prior year as the increase in net income of $5.4 million was consumed primarily by adding working capital to support the increased revenues and backlog.

Now I will turn to slide four, which lists the P&L in more detail. Since we will discuss the segment operating income later, I will add color only on the other categories. First, asbestos-related settlement and defense costs. As the asterisk at the bottom of the slide four describes, Leslie Controls subsidiary has been and continues to be named as the defendant in asbestos-related product liability action. During of the first quarter, our total expense for asbestos-related settlement and defense cost, net of insurance, was $1.1 million, slightly above the first quarter of 2007 of $1 million.

Regarding special charges, I did review that in slide three. Corporate expense has increased from prior year, driven primarily by two items. First is an increase in variable compensation, including share-based compensation. Second is an increase due to the timing of audit-related expenses between 2008 and 2007. Regarding net interest expense, it was lower in the first quarter 2008, primarily because we have continued to pay down a good portion of our revolving credit facility during '07 and '08, and into '08. Total debt was $25 million in March 2008 compared to $66.5 million in March of 2007. The other non-operating expense increase for Q1 '08 compared to Q1 '07 is due primarily to $0.3 million from net foreign currency translation losses and $0.2 million to other credits. Regarding income tax expense, the increase is due to the rise in the pre-tax income. The tax rate of 32% is the same as it was the first quarter of 2007.

Now to slide five, cash flow. Cash flow from operations and free cash flow remains steady Q1 '08 to Q1 '07. The significant increase in income of $5.5 million was more than consumed by working capital increases to support our growth, to build up transition inventories as you relocate facilities as we transition to low-cost region sourcing of internal manufacturing. We also spent an additional $1.1 million of capital expenditures in multiple areas, including investments to support new products.

Now, Bill will speak to our segment performance.

Bill Higgins

Thank you, Fred. I'll start with slide number six, our Instrumentation & Thermal Fluid segment results. As you noted on the slide, the segment had very good order and revenue growth compared to the same period in 2007. Regarding orders, in addition to the favorable currency impact, high growth was driven strong aerospace and maritime markets. Aerospace continues to have strong business from the high OEM build rates and strong military business, especially maritime helicopter landing gear. Maritime orders included a nice large U.S. Navy order and rebound in our UK Ministry of Defense orders. And total backlog ended the first quarter 36% higher than the first quarter of 2007, and 17% higher than how we ended the year in the fourth quarter of 2007.

Regarding operating margin, this segment's 11.3% margin was 410 basis points over the first quarter of 2007. And if you remove the impact of special charges for all periods, margin improved 340 basis points. These improvements came from the aerospace and instrumentation areas, partially offset by reduction of shipments and subsequent loss of fixed leverage in the UK maritime business, as we entered the first quarter of a low backlog in that business. And backlogs had rebounds in that business as of the end of Q1, 2008. The margins were driven by several factors, including price increases, favorable mix of sales and some benefit from the low-cost region sourcing project, particularly the actions that we executed last year.

Looking forward into the second quarter, we anticipate many of these gains continuing. However, we have had some delay in our low-cost region sourcing activities due to, as we discussed before, the high complexity, the many different parts or SKUs, the number of parts that we are outsourcing and the critical quality requirements. We are also feeling pressure from the continued devaluation of the U.S. dollar versus foreign currency, especially China. That said, our planned consolidation activities in Instrumentation & Aerospace are continuing. We anticipate most of those moves happening in the second and the third quarters. We expect – overall, we expect tremendous amount of improvement activities in this segment continuing during Q2 and the remainder of the year. This does bring some inherent risk with it and may cause volatility, especially as we look at it quarter-to-quarter. But we are confident we have the right processes and teams and people in place to continue improving operationally over the longer term.

Now, let me go to slide number seven, the Energy Products segment. The oil and gas markets served by this segment continue to be very healthy for both the large international project business as well as the domestic fabricated and our distribution products business. In addition, currency has had a very positive impact on revenues. The orders comparison for Q1 were up across all businesses compared to Q1 of last year and were also up 63% sequentially. Distribution products, our short-cycle MRO business in North America – in fact, we were sitting in our Oklahoma headquarters here in Oklahoma City – rebounded strongly in the first quarter, with backlogs ending Q1 54% higher than Q4 of 2007, after slowing down in the second half of last year. Inventories in the distribution system have been burned down sufficient or enough that supply and demand appear to be back in alignment and at healthy levels.

Both our domestic fabricated business and the large international project business also continued to build backlog sequentially during the first quarter of 2008. Regarding revenues, currency accounted for almost half of the revenue growth in the first quarter 2008 versus the first quarter 2007. Small organic component of 1% was driven by strong growth in our large international projects, were offset by weaker sales in distribution and domestic fabrication, which we – both had low backlogs entering 2008. As I just mentioned a few minutes ago, backlogs increased as we have gone through Q1 and entered Q2 in 2008.

As for profitability, this segment turned in another solid quarterly operating margin and over 16%; sequentially improved 90 basis points after removing special charges in Q4 2007 which included $1.2 million gain on the sale of land in China. During the first quarter, we shipped a very favorable product mix in our large international projects business. This included a large valve special project order that enhanced segment margin 120 basis points.

Let's now turn to slide number eight. On this slide, we point out our assumptions for our key end markets that we service. In our segments, we see almost universally solid foundations for 2009. Oil and gas prices are at record levels and consequently, rig counts are high. Aerospace OEM orders remain high and the military demand, particularly for spare parts and repairs, hasn't diminished. Maritime related to the U.S. and UK Navies have recently picked up, with the new sub and aircraft carrier program orders. We are watching Instrumentation closely, which is a global short-cycle business and is impacted by industries and capital spending around the world, but we haven't seen any dramatic changes there. In fact, at the end of Q1, orders have picked up nicely.

Let's turn to slide number nine now. Our expectations for revenue and margins in 2008 are shown here. For revenue assumptions, we are raising our expectations for the Instrumentation & Thermal Fluid Control segment to a range of 5% to 7% for the full year. We had previously assumed 5% growth which matched the Q1 results after removing currency effects. We have not changed our revenue outlook for the Energy segment. Net of foreign exchange benefits, Energy revenue grew only 1% in Q1. With the rebound we are seeing in the MRO short-cycle orders, we have a solid backlog.

As for operating margins, here we changed slightly from the last quarter, improving. And based on our progress in Q1, we have raised Instrumentation & Thermal Fluid product segment's operating margin from. 9.5% to 10% to 9.5% to 11%. Energy is currently in the range of 15% to 16%. We are seeing material cost inflation in our energy distribution products business, particularly driven by commodity inflation as well as currency and which we are offsetting with price increases. The assumptions on the other items we have on the page remain unchanged from our last call.

Overall, we anticipate having another strong performance in the second quarter with earnings per share before special charges at $0.74 to $0.83. And this compares favorably to $0.60 we achieved in the second quarter of 2007. So to summarize the outlook, we have good end market conditions. We have record backlogs. We are improving our performance to our customers and being rewarded with increasing orders. We have got stronger management teams in place. As I talked about before, we are driving improvement in all of our businesses around the world on multiple fronts to grow the top line and improve performance on the bottom line.

In fact, as Fred noted earlier, we hit a new record for margin expansion. We are going to continue to deploy and drive lean manufacturing methodologies around the world at all our sites and develop a culture that's an operational excellence culture for longer-term benefit for our customers and shareholders. We will also continue to rationalize product lines and consolidate facilities to reduce overhead fixed costs, as well as reengineer our supply chains, particularly globally, to take advantage of lower-cost foreign supply sources.

With that, we'd like to open it up the lines for any questions you might have.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) We will go first to Charlie Brady with BMO Capital Markets.

Charlie Brady – BMO Capital Markets

Hey, thanks. Good afternoon guys. Couple of questions on the Energy segment margins as we go into Q2 and the rest of the year. Give that we should probably have a pickup in the distribution business given the backlog build, could you talk about what that mix shift does to margins as compared to the large project business. Then also, should we expect then Q2 to see a sequential, but not year-over-year, but a sequential decline in margin because you are not going to have that large valve project hitting in Q2, as it did in Q1?

Bill Higgins

Let me start with the first point around the mix shift. We do expect to see a mix shift because the order backlog has filled in although we have been steadily building project orders, so I don't know if it's that significant overall. The project order backlog has been filling in nicely. The (inaudible) large scale project order to go out in sort of out into next year, but we have domestic fabricated project business that we are filling in for this year. It will be somewhat of a mix shift as we go forward. We believe we can leverage volume on the short-cycle business, as I've talked about before, as we ramp up the volume there and leverage fixed costs. But we are also very cautious of the increase in material costs coming out of China and our supply chain that comes out of China. So we are watching those cost increases as well. Your Q2 question was, would we see a decline because of the very nice project we shipped in Q1? We will probably see a margin decline as we go into Q2 relative to that.

Fred Burditt

Assuming that we don't have that order, obviously, in the second quarter, as we said, it impacted the quarter by 120 basis points. So, assuming we have no replacement for that, it will have some depressing effect on the quarter. And the other question, if you look at mix of businesses, the project business tends to have all the issue with mix of sales or orders, tends to have better margins overall than the other part of our segment. I think both of those, it will have a little bit of a depressing impact, all things being equal.

Charlie Brady – BMO Capital Markets

Talking about pricing in the Instrumentation business, for a long time, you guys were hitting a ceiling against the major competitor in instrumentation market who wasn't raising prices. What is allowing you now to get pricing through? Is it from a competitive standpoint, others are raising their prices also?

Bill Higgins

We have seen a little price movement in this year that's kicking in we believe based on our best estimates in the second quarter. So we have raised prices ourselves. We are testing that.

Fred Burditt

I wouldn't call it a dramatic change. But there is a little bit of movement there.

Charlie Brady – BMO Capital Markets

The bulk of the margin expansion in Instrumentation then would not be from price?

Fred Burditt

Just round numbers, about a quarter of that expansion was due to price.

Charlie Brady – BMO Capital Markets

Thanks very much.

Operator

We'll take the next question from Kevin Maczka from BB&T Capital Markets.

Kevin Maczka – BB&T Capital Markets

Good afternoon.

Bill Higgins

Good afternoon, Kevin.

Kevin Maczka – BB&T Capital Markets

To follow up on that price question and ask you a little bit in a different way if I could, what other impediments are there to you taking more price? Is there some long-term contracts on your non-MRO business that maybe, even if you have the ability to price higher, you may have to wait until those contracts come due?

Bill Higgins

There are long-term contract prices in particular businesses. The aerospace is a good example. The OEM businesses are typically contracted over a long term and to change prices takes a significant negotiation. The project businesses that run across energy and some of our smaller project businesses in the other segment are pricing out into 10, 12, 14-month time frame and those prices are negotiated at the time of the bid. There is typically a bid competition. So, we test the pricing on the project businesses as well. But, if we overprice on those, we end up losing the bid. So we were testing on both sides of it. And then the short-cycle business, we've raised prices as we mentioned in both energy on distribution products as well as instrumentation, and there we really tested it and watched the volume and price elasticity and the reaction in the market.

Kevin Maczka – BB&T Capital Markets

Okay. And then question on the commodity cost side, if I could, whether it be steel, aluminum, brass, any of the metals that you are buying, can you talk a little bit more about what you are seeing there. It sounds like you are getting a little bit of price, but are you actually able to expand margins based on that price, or only attempt to recover your higher cost?

Fred Burditt

I think to the large extent, we are just being able to recover our higher cost. And I guess we talked before, it's hard to get price. And there is a long tail on some of our projects. So, our ability to get price over and above most of our material inflation is not significant.

Bill Higgins

And as we talked about in the past, particularly in instrumentation, as restructuring, the lean and consolidation of a facility that we are driving to expand margin.

Kevin Maczka – BB&T Capital Markets

Okay. Just one other quick one, if I could. Can you comment a little bit on seasonality as it relates to margins because if I look at the last couple of years, it looks like the first quarter tends to be the lowest margin quarter. I know there are mix things that you mentioned that may kind of skew things a bit as we go forward. But, in general, would you expect that to still be the case as you look out to the rest of the year?

Bill Higgins

Let me try that from a slightly different angle, Kevin, because it's an astute question. In many of our businesses, historically, the first quarter was a low quarter for us. A lot of that had to do with how we ran our operations. A big push at the end of the year shipping the government or military work, as we become more of an operationally excellent company, as we become more linear and ship daily and weekly on a more predictable and dependable basis as we have improved across the company, we should see less and less of that. So, we had a very good Q1 and better than our previous first quarters. I wouldn't necessarily say that's a low point. The other thing I heard and when I was for instance out here with the distribution products representatives covering the market that 2008 looks a little different than prior years in that it started off with low orders because of the channels were overstocked last year. And then, it looks like it's picking up as we get into 2008 and in prior years that would have probably been the opposite. We would have started out with a high order rate, a high backlog of orders into the year and then sort of burned that down through the year. So there is another fix going on. Not necessarily seasonality that you'll see over the long term.

Kevin Maczka – BB&T Capital Markets

Okay. Thank you.

Operator

We will go next to Mike Schneider with Robert W. Baird.

Mike Schneider - Robert W. Baird

Good afternoon, guys. Bill, maybe just sticking with KF for a second. On that question or comment about the seasonality that is different this year, how much of what we saw this quarter, in the orders at least, on the MRO side, is due to restocking at the distributors? We hear comments out of the distributors that they are incrementally much more positive and I presume it's just because some of the new discoveries in gas and oil prices. But, do you sense that this quarter was unusually boosted because of that channel fill?

Bill Higgins

I guess, before I try to quantitative, my action is that there is a significant increase due to restocking. There has also been real strong international activity that we've seen growing. And that's somewhat of a reaction to sort of the coming off of the negative effect in 2007 where overpurchases were and overstocked distribution. I do think some of it is a pickup that we saw particularly at the end of Q1 and as we entered and through the month of April. So, March and April, real strong order months. We published the March data, but we are seeing good conditions in the market.

Mike Schneider - Robert W. Baird

And I'm sorry, there was a number you mentioned in your opening remarks, your segment details. That KF was up 54% or the MRO was up 54%. Was that backlog orders year-over-year or sequential? If you could repeat that?

Bill Higgins

Make sure I get that right. Ending backlog, first quarter was 54% higher than they were over the fourth quarter of 2007.

Mike Schneider - Robert W. Baird

And that is just for the MRO portion of the business?

Bill Higgins

That would be – that's the total energy?

Mike Schneider - Robert W. Baird

That's the total energy?

Bill Higgins

Hold on a second. We are just checking here to make sure we have the accurate numbers for you here.

Fred Burditt

That's the total segment.

Bill Higgins

That is the total segment. Not just the North America piece.

Mike Schneider - Robert W. Baird

Okay.

Bill Higgins

North America did rebound, but total backlog ended 54%.

Mike Schneider - Robert W. Baird

And that's driven by strength on both sides of the business – engineered projects.

Bill Higgins

That's international projects and MRO.

Mike Schneider - Robert W. Baird

Got it. Then in instrumentation, the two facility closures or moves that are underway, can you give us a sense where you are in that process, have you actually started equipment in process in the move? And then, what's different this time because there certainly have been disruptive moves in the past, what are you doing new or different this time around to try and minimize that risk?

Bill Higgins

Yes, the instrumentation move is still underway. Our goal has been to have everything moved out of the facility by the middle of this year. We are generally on track of that. It might have moved a month or two. But, say by Q2, Q3, we will have moved the majority of production out of the second facility we have in South Carolina. What's different this year, is we really taken a harder project management, Six Sigma Lean approach to the move process. It doesn't mean there isn't risk; there always is risk when we pick up machinery and moving it. If the machine hasn't [ph] been run for a long time, getting it started may be a risk. But we have stronger teams doing it and a much more rigorous review process in what we call repositioning competency that we have been developing. And there is a significant amount of material that we are outsourcing along the way and we were outsourcing ahead of the move. So we outsource material, we qualify the outside vendor that might be in Asia. There are new material in before we do anything to shut down the machine. So, one of the reasons you see a little uptick in inventory because we build inventories before we make those moves.

Mike Schneider - Robert W. Baird

Okay. And then the margin guidance for instrumentation, you bumped it up on the high end of 11%. But, with the pricing that is in place already and that will roll through for the balance ever the year, you are doing over 11% margins now for six months. Have you just built in and given that you are above the high end of the range, have you built in a cushion just for the facility moves or do you expect a mix shift, just give us some sense as to why you wouldn't finish higher than that.

Bill Higgins

We got a little bit of tailwind in the first quarter on stainless. Sur charge has not been quite as high as we thought or as quite high as they were last year. We have seen them come back up a little bit. We also had cost in our budgets and in our forecast for the move that due to the complexity of taking some of the next level of components offshore, has delayed the move and has delayed some of that cost. And we also have in our budget plans to expand our global sourcing and in the investment in that in Asia in the second half of the year.

Mike Schneider - Robert W. Baird

Okay. Then just on the guidance practices, if you will, this is twice now in six months where the guidance on the forward quarter proved to be disappointing and there were elements built into it and then, lo and behold, when the quarter is released and in this case, you actually positively preannounced, the numbers prove to be significantly higher. What is it within a quarter and maybe use this quarter as an example, that there are such huge variability and inability to pinpoint where you are going to be in the quarter? Is it simply a couple shipments (inaudible) make the difference?

Bill Higgins

In this case, it's two-fold. The project businesses, as I said before, are – they are very hard to predict and they are very large orders. So, these are very – these valves that we shipped in this project in the first quarter there, they are million dollar valves. And they are very hard to predict exactly when we are going to get not only through the whole process of certification but then the shipping process and schedule the project process. So there is a timing issue that is difficult as well as a cost because a large part of these orders are – they are all custom-made, they are all made for the first time. I'm trying to really analyze and forecast what our costs are going to end up being has been tricky. That's the lumpiness of the project business. The thing that is different this time in the first quarter for us is that all of the businesses across CIRCOR except for one, and the one that is the lower performing one we knew about, but all of the others performed at least at or above where we expected it be and a couple of them, much better. So, it's kind of the opposite of the perfect storm.

We have the size of our company, and the diversity of the business units that we have around the world and the amount of change that is underway right now with lean and Six Sigma and the plant moves and the product line rationalizations, and the upgrades, and leadership teams, there is just a lot of moving pieces. Typically, we have some businesses that do a little bit better and some that do worse and they sort of negate each other when we do our forecast. And that didn't happen this time. Everybody kind of performed to the upside.

I would love to be able to sit here and say that's the way it's going to be going forward. But, I think what's more accurate to say is, there is so much change going on in these businesses, it's really going to be hard to pin down quarter-to-quarter. We will do our best, but longer-term they are going to improve. And that's kind of our goal with these businesses. I'm not trying to cop out on the question. I would have loved to be able to forecast the higher performance that we delivered. But, for all of the businesses to have performed well is not something I would have forecast.

Fred Burditt

Yes, I think to add to that a little bit. The other major factor across our business has been mix in this quarter. As Bill said, those mixes all shifted in the right direction all at the same time. So, whether it was product mix within individual businesses or whether just mix between our businesses, they tended to mix up as we talked about with the big project businesses in the Energy segment, even within our Thermal Fluid and Instrumentation segment, we had examples where we had favorable product and business mix in the quarter.

Mike Schneider - Robert W. Baird

Okay. And I didn't mean that to sound like a complaint because you deserve a high congratulation on a great quarter. Thank you.

Bill Higgins

Thanks.

Operator

We will take the next question from Ned Armstrong with FBR & Co.

Ned Armstrong – FBR

Thank you. Good afternoon. In the presentation, you cited the maritime industry is being strong. Can you spend a couple minutes talking about the drivers behind that as well as the duration that you anticipate for strength in that business?

Bill Higgins

That's a very special case. It's really a case where the maritime, particularly the Navy business that we have, has been on a decline. The U.S. Navy business that we have has been on a decline for a fairly long time. So what we were talking about now is orders. There has been a lot of engineering work and investment by our teams and have won programs on the aircraft carriers and then behind that, there are some other Navy ships. There is not a lot, but there is some other Navy ships around that, for us, will turn the corner. And so, we are starting to build a backlog for the longer term in the Navy that we have only seen a declining backlog for a number of years, at least four or five years that I can think of. That's on the U.S. side.

On the UK side, the Navy spend as well on the UK side has been stifled in the last couple years with all of the shift of Department of Ministry of defense funding for the war in Afghanistan and Iraq, away from Navy spend. So we also a decline in our UK Navy order rate in the last year. And that has picked back up with these two programs and a couple of other programs the Navy and the United Kingdom is going forward with. So, these are orders that going into our backlog as a positive trend, but a lot of those orders don't get delivered and converting into revenue until 2009 and 2010.

Ned Armstrong – FBR

Okay. Thank you.

Operator

We will take the next question with Ron Fischer with U.S. Steel.

Ron Fischer – U.S. Steel

Good afternoon.

Bill Higgins

Good afternoon, Ron.

Ron Fischer – U.S. Steel

Earnings likely to be up this year. Your forecast for cash flow is flat. I have to think then that working capital is going to continue to be a use of cash. I'm wondering with all the good things that you are doing, leaning out and improving your operations, why working capital wouldn't be an addition to cash rather than a use?

Fred Burditt

I think we will have positive cash flow by the end of the year. A lot of our inventory improvements that are going to come from this activity is going to happen toward the very tail end of the year, plus the receivable piece – timing of receivables, how much we are going to have to invest on receivables for the added backlog.

Bill Higgins

Let me add an operational flare to that because we spend a lot of time working on that inside. The benefits from lean that you would see in our factories and those of you who'd have visited them, will first show up on the factory floor. You visually see a better flow of material. The customers will feel better on-time delivery performance, responsiveness, will show on quality. We will start to see work-in-process inventory improvements. But because of the mix of product that we have in CIRCOR and the number of different product lines and types of products, particularly specialized customized products. The inventory piece is going to take a little bit longer and the projects we have underway to redesign and reengineering our production, our supply chain processes, will drive improvement in work-in-process inventory, but we will probably add inventories a little bit as we outsource more and more, as we get through that period. So, the inventory improvement is going to be the last one to show up on the bottom line. We will work through that and we have fully-loaded plans to work it and we were working it very aggressively and the management teams all have targets, significant targets, particularly in the second half of this year, to improve inventory turns. There is still a lot of work to do. We were in inning one or two on that front, in that game.

Ron Fischer – U.S. Steel

All right. Thank you.

Operator

We will take the next question from James Wong [ph] with Gabelli.

James Wong – Gabelli

Good morning, Bill and Fred. Good afternoon actually. Could you talk about acquisitions and possible divestitures. I know in your last couple months, kind of you looking at your businesses and just wondering what you've come up with so far in terms of what you consider core and what you want to grow?

Bill Higgins

We continue to search for acquisitions, we are continuing to meet with companies and evaluate and as we've mentioned before in 2007, we struggled with the high price premiums. We walked away from a couple of decent deals late in the process because prices just got too hefty for us, so we couldn't see a return on our investment. So we were still working that front as we go, as we have. Possible divestitures, we've divested a couple of smaller product lines over the last two years now with the newer leadership teams in place. A couple in Europe. A couple of product lines in the United States. Very, very small ones. But we are going to continue to look at that and develop as we filled in our management teams and our executive teams, we are going to continue to look at the strategy overall. So we don't have anything to report or announce on either the acquisition or the divestiture front. But, just want everybody to know, we are still working through those and we have got the analysis going.

James Wong – Gabelli

Could you talk about the areas you are looking at for potential acquisitions and if you are interested in putting on another leg [ph] in the company?

Bill Higgins

We have communicated. We are more ready than we would have been a year or two ago to make a larger acquisition. An acquisition in the say $100 million to $200 million range is something we would not have considered two or three years ago, when I joined CIRCOR. We couldn't have handled it or integrated it very well. We have the management and operational teams now that we will consider a larger deal as they fit within our core competencies.

James Wong – Gabelli

Okay. And then I guess, just shifting gears a bit, last two quarters, your margins outstanding in both segments. Have you kind of looked at your long-term outlook for margins in both segments? Have you bumped it in terms of what the potential margins could be over the next three to five years?

Bill Higgins

Well, we have. I think we are going to have to go back and look at it again. As we've talked about before, we typically looked at energy and believe that 15% range was one we could sustain and keep working productivity to offset material costs, as well as the entrance of a lot of other plays into a healthy market and being competitive there. The harder question for us has been on the Instrumentation and Thermal Fluid side, how far we could go with improving the margins, and we've said in the past, we have a path. We have a path that we see to be kind of 11% to 13% range on operating margins for that segment. We are going to keep evaluating that as we go forward. But, over the next, I think your number was three or four years, that's kind of been our thinking.

James Wong – Gabelli

Right. Okay. You are right there involved pretty much. Great job, so keep doing it.

Bill Higgins

Thank you.

James Wong – Gabelli

Thank you.

Operator

We will take our final question from Richard Glass with Morgan Stanley.

Richard Glass – Morgan Stanley

Hey, guys, nice quarter.

Bill Higgins

Thank you, Richard.

Richard Glass – Morgan Stanley

Way to set the bar high for yourself going forward, Bill.

Bill Higgins

I know.

Richard Glass – Morgan Stanley

Can you just help us understand on the SG&A line, how much – it's flat as a percent of sales and I'm wondering how much you are running through in terms of extra costs or redundant costs given some of the moves and programs you have in place, and how that should progress from there in terms of getting more leverage out of that?

Bill Higgins

If I take acquisitions off the table for a minute, I expect to make sort for the longer-term incremental improvements in SG&A. I'm afraid you want to add specifics to that, but we saw a little bit of improvement over the last six months in SG&A. The project businesses and there is a lot of engineering and sales cost, we have to add upfront when you grow that business. That's a little tougher. Some of the product businesses, as we consolidate facilities, as we create a more lean production process, I fully expect we can get more out of our SG&A dollars.

Fred Burditt

We have really not spent tremendous amount of money in these moves. We are spending $0.5 million to $1 million range in these areas. It's not been a dramatic impact.

Richard Glass – Morgan Stanley

All right. Thanks, guys.

Operator

That does conclude the question-and-answer session. I would like to turn the conference back over to Mr. Higgins for any additional or closing remarks.

Bill Higgins

I would just like to thank everybody for your support and your interest in CIRCOR. We had a great quarter. We are working real hard across all of our businesses to do the best job we can for our shareholders. It's not going to be a linear process. The improvements that we are making across the businesses are going to be in a stepwise fashion. We are going to keep at it for the long-term haul and we look forward to our next earnings conference call on July 31, 2008. Thank you everybody.

Operator

Thank you. That does conclude today's conference. We thank you for your participation and you may disconnect at this time.

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Source: CIRCOR International, Inc. Q1 2008 Earnings Call Transcript
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